work? YES. Did the new perforating guns fire? NO. Is the well on production? NOT YET!

That’s the succinct summary of the April 9, 2012 conference call in which Jim Bob Moffett laid it all out for those who were listening. But not many seem to have heard the complete message: most of the equipment worked beautifully and this well wants to flow. It’s huge for McMoRan and also for the U.S. of A.

McMoRan held yet another update of its “progress” or perhaps better described as its latest “Problems” report with its Davy Jones #1 Well. No, the well is still not online and producing. Davy is still not yielding up his treasures in profusion but for sure, his grip has been loosened. Judging from some of the reports written after the conference call and recent stock price declines for both MMR and EXXI, most folks missed the important stuff. Believe me, I’m as frustrated as everybody else and blew my cork, too, last week at the lack of new news. Then came the call. Read the transcript if you haven’t. Moffett laid it all out for us if only people were listening. You don’t even have to read between the lines to get the complete picture. If we are frustrated, just think how they must feel.

McMoRan and its partners, Energy XXI, Tex Moncrief and Nippon Oil, have earned the respect of everyone working in the ultra deep Gulf of Mexico, shallow or deep. Chevron recently invited the group into its Lineham Creek well onshore Louisiana in the Rockefeller Preserve. Why? Because after spending a giant fortune for a small company, Jim Bob Moffett’s group knows more about the seismic, the challenges of drilling 6 miles below the mudline, and controlling 400+ degree temperatures and 25,000+lb. pressures at the bottom of these drill holes in the ultra deep Gulf of Mexico than anybody else. Those assets count for a lot even if the stock is being punished in the short term by those who don’t value the long term view.

This project has overturned what had been common knowledge that the Gulf of Mexico was an exhausted basin for hydrocarbon discoveries. It has extended the limits of how to use and interpret seismic data. It required the invention and manufacture of a whole new level of equipment engineered to safely control and conquer the pressures and the temperatures in this new frontier. Remember that Exxon Mobil withdrew from its efforts at Blackbeard West. Its fears of another Exxon Valdez and its fears of those very concerns of temperature and pressure caused it to walk away after pouring over $200 million down BBW which this group now controls. Several years ago now, the MMR group drilled just another 2000 feet at BBW and made a major discovery that started this whole odyssey. If it were easy, XOM would have stayed at the party.

The discovery at Davy Jones 1 well over two years ago has presented all imaginable problems for the team to overcome in the interim. Many of those problems at DJ have occurred because as a “money saver” the idea was to reenter an old unsuccessful well bore that had already been drilled to 20,000 feet, where nothing was found. The original hole was never intended to go down to 30,000. The result is that the initial casing diameters weren’t that huge and the bottom of the hole was telescoped down to 3 5/8’’ pipe, smaller than your fist. There have been unending problems because of that tiny space in which to do just about anything; retrieve a broken tool or run perforating guns to bring the well into production. Rest assured, no small holes will ever be tried again.

This is a huge science experiment. The money spent here is not just about Davy Jones 1. That’s why the team is intent on this completion and hasn’t walked away. The question about whether Davy Jones 1 can be economic is the wrong one. DJ1 has become a massive research and development project for the entire Davy Jones Field and the Ultra Deep Gulf of Mexico play which extends far beyond this one well. Everything learned will be applied to completion of every one of the other wells MMR has already drilled to discoveries and to the future wells still in the planning stages. That includes Davy Jones 2, Blackbeard West and Blackbeard East, Ship Shoal 188 (aka BBW#2), and Lafitte. Each of these wells represents a major discovery of up to 500’ of pay. The lessons will also apply to Captain Blood and Barbosa, England and onshore prospects, too, waiting in the wings. There will be dozens more wells beyond that.

What Davy has shown so far is that almost all the equipment designed for the well and that took months to build, worked perfectly: Blow Out Preventer, Safety Valves, Lubricators, and so on. When the well was perforated, it did flow despite only small holes from small guns after the big ones failed to fire. The well was getting up a head of steam that would have cleared the mud out of the hole. If only it hadn’t been interrupted.

The following is a direct quote from the April 9, 2012 transcript of MMR’s investor call to update everyone on Davy Jones.

James R. Moffett:

“the well was flowing but we had to shut in for three hours to skid the rig back. That was the requirement of our permit.”

Joan Lappin Contributor Only one type of new equipment didn’t work as planned. We know that the new ballistic guns that were to be ignited by a laser-like trigger never fired. Even so, the well was flowing as it should have until the permit required the operator to shut it down and skid the cantilevered rig back away from the production platform. That three hours clogged the well for now until it is reworked. We know the perforation was just partial. So maybe the delay of a month for a corrected completion will be a good thing in the long run in terms of what is ultimately recovered from this well.

Even so, Moffett went on to share with us:

“we feel comfortable that we had some good penetration, but not complete penetration and that the mobility in the sand once we get this new casing gun perforation through these zones ought to give us what we all have been looking for.”

In the post Macondo environment where both Government regulators and operators themselves are well aware of the potential risks, the original permit required that the rig be skidded back from the production platform and the well head. To do that the well had to be shut down for three hours. During that time, the well clogged up. In the newly issued work over permit, Dept of Energy regulators have agreed that in retrospect shutting in the well was counterproductive. The new permit has no such requirement. Once it starts to flow, it won’t be shut down.

Everybody respects MMR and the job it has done on all aspects of this ongoing project. To date there have been no other discoveries by any other companies in the ultra deep defined as 25,000’ below the mud line. This is all new ground right down to the seismic interpretation by MMR which has been refined in the last two years. Everyone is watching. All the majors are monitoring Jim Bob’s every move. Chevron is teaming up with them onshore.

The costs of this well are not about Davy Jones 1 and whether or not it will be economic at present depressed gas prices. Natural Gas is a commodity and all commodities are cyclical. Nat. gas was in the teens when this project was started and not the $2 at which it is presently trading. It won’t be $2 forever as we ship it overseas or prices return to normal in our country. Davy Jones 1 is about “proof of concept” and ironing out all the kinks.

MMR’s other wells are not being completed until all these mechanical issues are worked through. In a recent presentation, Energy XXI’s CEO John Schiller said: “for sure, we won’t be drilling another small hole like this one ever again.” That is why Davy Jones 2 is a second half event for 2012.

Once Davy Jones 1 starts to give up all of his bounty, which should be soon now, there will be few better gas plays you can find in the United States. If we are lucky enough to have liquids in addition to just gas, all the better. Then, the economics will improve dramatically even with gas at $2 since this play should prove to be the lowest cost gas produced in the entire United States. For sure, it puts shale gas to shame on a cost basis. And if the United States ever adopted an energy policy that would put clean burning natural gas front and center, it would be the best of all possible worlds.

Joan E. Lappin CFA Gramercy Capital Mgt. Corp.

Of the companies mentioned, Mrs. Lappin, Gramercy Capital Management Corp. and its clients own shares in Energy XXI and McMoRan at this time.